Cost of Production
There are various costs that Starbucks® faces within the company: fixed costs, direct and indirect costs, and operating costs. “Fixed costs are costs that remain constant as output changes” such as “retail space, payments for fire insurance, and payments for online and television advertising” (Hubbard & O’Brien, 2015, p.354). Direct costs include expenses such as wages expense, equipment expense, and supplies expense. Advertising and payroll are classified as indirect costs. Advertising from Starbucks® varied between the years 2015-2017. According to Starbucks Fiscal 2017 Annual Report, “advertising expenses totaled $282.6 million, $248.6 million, and $227.9 million in fiscal 2017, 2016, and 2015, respectively” (Starbucks® Fiscal 2017 Annual Report, p.58).
Over the years 2013 through 2017, the costs of goods sold (COGS) kept increasing at a quick pace. The COGS had several factors that impacted the rising expense. Starbucks® opened a total of 7,572 stores between the years of 2013-2017 (“Number of Starbucks stores worldwide 2017”). This resulted in the need for more raw materials, especially coffee beans. Since coffee has become a high in demand material, the supply for premium coffee beans is limited; therefore, the need to increase the price of coffee beans has spiked. Coffee is becoming more expensive by the pound, leading to Starbucks® having to raise its prices on its products. Shown in the chart below, COGS has been gradually increasing within the years, mainly because of all the coffee needed to continue operating all of the Starbucks® stores.
According to the financial information in chart shown below, in 2013 Starbucks® had an operating loss of 325.4 million. This was because of the termination of an agreement between Kraft Foods and Starbucks® that “…limited Starbucks to selling [coffee] pods of a kind that worked only in Kraft’s Tassimo machines” which resulted in Starbucks® paying $2.75 billion to Kraft Foods (Strom, 2013). However, within the next couple of years, Starbucks®’ operating income continued to increase, as shown in the chart below. Despite the prices for coffee beans rising, Starbucks® was able to continue to raise its profits through cost dividends, shares and investments, including the raise of its products.
The market Starbucks® shares is the coffee industry. Starbucks®’ top competitors are currently Dunkin’ Donuts and McDonald’s. According to the chart below, Starbucks® holds a market share of 59.2% in the coffee industry, while its top competitors, Dunkin’ Donuts and McDonald’s, hold 14.4% and 16.3%, respectively, of the market share (Team, 2016). Dunkin’ Donuts and McDonald’s have a slight advantage over Starbucks® because of their low prices for high quality coffee. However, Starbucks® has found alternative ways to keep the competition strong, mainly by focusing on the needs and wants of its loyal customers.
According to the textbook, “barrier to entry is anything that keeps new firms from entering an industry in which firms are earning economic profits” (Hubbard & O’Brien, 2015). The main barrier to entry that insulates Starbucks® from competition is economies of scale. This is mainly because of the amount of Starbucks® stores open across the globe, more than 24,000. Which means that Starbucks® can “…spread the high fixed costs” of its products “…over a much larger quantity” (Hubbard & O’Brien, 2015). For instance, with the coffee bean prices increasing, Starbucks® will find it affordable to purchase a bulk amount, since it is already an established firm with multiple locations; however, a new firm will start off small and find that purchasing a bulk amount will be out of its price range and a waste of money, since consumers will be hesitant on purchasing coffee from an unknown firm.
Entering the coffee industry will have a high barrier of entry, mainly because of the cost of production and the competitiveness of already established firms. Starting a coffee business will require a starting cost of a couple hundred thousand dollars, in addition to the raw materials needed to make the products. With well-known firms, such as Starbucks®, Dunkin’ Donuts, and McDonald’s, competition will not be light. Consumers want the best coffee at affordable prices and they would rather go to a business they already know or trust. Therefore, entering the coffee industry will not have an easy start, but can definitely be successful with the right investments, marketing, and competitive strategies.
Starbucks® can manage future production by providing more variation on foods and merchandise. Since coffee beans are already expensive, Starbucks® will be balancing out the expense of coffee by providing foods or merchandise that are not as expensive to produce. Customers do not only go to Starbucks® for the coffee, but also for food and snacks it sells. This strategy will allow Starbucks® to make more profit out of items, allowing it to continuously fund the coffee expense without a big loss. The demand in coffee will continue increasing over the years and the supply will be limited; therefore, having a safe source of income to cover the expense of coffee beans will be essential in the continuous success of Starbucks®.
Because Starbucks® holds a high reputation with its customers, the introduction of more variation among foods and merchandise will spike. Customers are more inclined in spending their money with companies whom they are familiar with. According to the market share chart mentioned above, Starbucks® will be showcasing its future production to nearly 60% of the market share. Starbucks® continuously finds methods to keep a competitive edge with its top competitors. For example, the “pumpkin spice latte…launch followed more than 150,000 incremental visits on the first two days,” whereas “…its competitors, McDonald’s and Dunkin’, which launched the same coffee a week earlier, saw their market share recede” (Team, 2016). This is mainly because Starbucks® remains flexible to its customers by “adapting to changing consumer tastes and preferences” (Team, 2016).
Starbucks® can remain successful by new products to offer based on consumers changing tastes. Like mentioned earlier, Starbucks® is very flexible into adjusting its menu and ingredients by the likings and preferences of its consumers. Almond milk, coconut milk, and soy milk are some of the new add-ons that Starbucks® has provided for consumers who are seeking dairy-free products; in addition, in order for consumers to get this substitution in their drinks, Starbucks® charges its customers $0.60 more (Team, 2016). However, because Starbucks®’ products have very little price elasticity, consumers demand will remain indifferent.